Title: 6 Popular Mistakes in Retirement Planning and How to Avoid Them
Standfirst: Retirement planning is one of the most essential financial goals that all working adults have to undertake. However, many of us underestimate the amount of money we need for a comfortable and independent life after retirement, falling into the trap of having too little, too late. What are the common pitfalls of retirement planning, and how can you avoid them?
It’s not sexy, but it’s real. Many of us are motivated to work hard so that we can enjoy a certain lifestyle today. However, we rarely like to think about what shape life could take in our later years. If you have visions of spending your days engaged in fulfilling activities such as travelling the world, volunteering for charity and pursuing a project you’re passionate about, or just to be independent and able to afford the best things in life - you need a retirement plan.
Many Malaysians tend to make mistakes either in not planning for retirement at all, or not having the right strategy. The scenario is rather grim. According to a study by the Asian Strategy & Leadership Institute, about 90% of rural households and 86% of urban households in Malaysia have zero savings.
The study reveals that out of 14.5 million working Malaysians in the country, 89% are earning less than RM5,000 a month, and only 6.7 million are active contributors to the EPF (Employees Provident Fund). Of these 6.7 million people, only 22% would have saved enough at retirement to sustain themselves for 20 years.
The EPF suggests that the minimum amount needed for retirement is RM196,800, based on a monthly expenditure of RM820 for 20 years. Imagine living on this amount today, factor in inflation, and visions of your dream home, coasting around in a Ferrari or jetsetting to Europe twice a year will promptly fly out the window.
The key to success is getting your retirement plan right. Here are 6 of the most common mistakes in retirement planning to avoid.
1. Not having a goal or a plan.
Many of us assume that our later years will be covered by our EPF contributions, or that our children will to look after us. However, taking a passive stance on your retirement and underestimating financial needs is a rather big gamble. In fact, news reports tell us that many Malaysians go through their EPF savings within 5 years.
The United Nations also issued a report in 2015, stating that by 2030, Malaysia will have an aging population with those aged 60 and above making up 14 per cent. From there, it would only take 15 years to 2045 for the country to become a super-aged nation, with 21 per cent of the population above 60 years old.
With estimates that more than half of those over 60 will have insufficient retirement funds, the burden will fall to the diminishing working population, who would have to bear rising costs of social welfare and healthcare. This would then drive taxes up significantly, putting financial strain on those of working age.
Having a plan in place would ensure your independence in old age, and relieve future generations of financial pressures, taking the strain off of relationships.
2. Not growing or diversifying your savings
This is a prime mistake. After reading the above, you would have realised that EPF contribution should not be your only source of retirement funds. Despite growing at a rate of about 6% per annum, there are many additional options with similar or better returns.
It may warrant some research and advice from a trusted financial expert, but you will find there are different ways to make your money grow be it through a Private Retirement Scheme or other savings plans, investing in unit trusts, purchasing real estate, placing cash reserves in high-interest fixed deposit accounts or other means of generating long-term, consistent and competitive returns at minimal risk.
3. Withdrawing from your EPF Account 2
While your Account 1 is strictly off limits till retirement age, EPF has made it possible for you to make withdrawals from your Account 2 under special circumstances. If you need assistance with the down payment for purchasing a home, or have difficulty repaying a mortgage, require funds to further your education or are faced with an unexpected medical bill, you are entitled to apply for a withdrawal from your Account 2 under certain terms and conditions.
However, unless you are in a bind with no other options, and are disciplined enough to replenish the funds when you’re back on your feet, it may be wiser to leave that money in the account, especially if the funds aren’t being used on a growing investment.
Instead, look into growing your EPF funds further. Your Account 1 may be off-limits for withdrawals, but it is not off-limits for investment. The EPF allows members to withdraw up to 20% from their Account 1 for investment in EPF-approved unit trusts after the Basic Savings* in Account 1 has been set aside. Make your EPF contributions work harder for you!
4. Starting the savings process too late
When we begin our corporate lives our thoughts often go to how much we will set aside to buy the things we want, while saving for our retirement plan goes on the backburner.
This is another common mistake because the sooner you start saving, the earlier you could retire. Why wait till you’re 55 when you can perhaps retire at 35 to pursue your passion projects?
Starting the savings process early has its benefits by virtue of two magical words: compound interest.
What is compound interest? It's interest that earns interest. For instance, suppose you saved and banked in RM1,000 a year ago. If it earned 3% in interest, this year you'll be earning interest on $1030 (original savings plus the interest earned). That might not seem like much, but understanding this simple concept can enable your wealth to rapidly snowball.
If you begin with a RM10,000 deposit for example, and plan to continue saving RM1,000 monthly for 15 years at a rate of 3%, by the end of the term, you would have amassed RM 241,647.01 thanks to the concept of compound interest, a much larger amount than if you were to just slip the money under your mattress!
It’s also advisable to start saving in your 20s, allowing more time for the magic of compound interest to work, and if you look at investments which give you a higher percentage of returns in interest - well, you get the picture.
There are fun online tools that can help you plan your savings and investments such as Calculator.com.my or speak to a trusted adviser.
5. Spending your bonuses immediately or allowing debt to pile up
It is a fact of life. Money is easy to spend, but far more difficult to earn. Many people of working age believe that since they are contributing to EPF, have a home loan in progress, or some savings set aside monthly, that they are safe to spend their annual bonuses.
Now that you understand the concept of compound interest, you need to understand that it is a double-edged sword which could work against you. Compound interest on credit cards and loans could also make your debt level snowball.
So, instead of spending your bonuses immediately, look at how you can use it to get rid of debt (study loans, credit cards, car or home loans) or grow your savings/investment pool.
This doesn’t sound like a lot of fun, but so as not to eliminate all the joy from your working life, perhaps you could also look at having different savings buckets. After your bills, payments and emergency cash funds have been looked after, see how much you have left over from your bonus and allocate different amounts to a travel bucket, or a new mobile phone bucket, or other purchases you may wish to make, not forgetting your savings or investments. This way, you can still experience rewards before you retire.
6. Not accounting for health costs
Health costs are on the rise. According to PwC’s Health Research Institute, medical cost trends in 2017 will experience a 6.5% growth rate. Although this growth rate is the same as last year’s, it still outpaces general economic inflation.
A mistake that many Malaysians make is to take their health for granted and not work in a back-up plan for healthcare costs or illness. As we’re thinking about retirement, it is highly possible that medical costs will be far higher than they are today, and there will be increasing needs for healthcare as we grow older.
It’s therefore important to consider a medical protection plan to cover hospital, outpatient and other healthcare needs. Beyond coverage, it’s also important to note that after 65 years of age, persons with known medical conditions, who have made claims on their insurance policies may not be able to renew their policies, or may only be able to get limited coverage. It’s important to ensure that your retirement plan includes contingencies for potential situations like these.
Speak to someone you trust or explore your options for health coverage. You can also find out more about medical insurance here.
*Basic Savings is a fixed portion of the total amount a member has in their EPF Account 1 which is untouchable. This amount increases at different age levels and serves to enable EPF members to accumulate a minimum savings of RM120,000 at age 55. It is compulsory for EPF members to retain the Basic Savings portion in their EPF Account but they can withdraw up to 20% of their total amount for investment in unit trusts, after the Basic Savings has been deducted.
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